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The Week Ahead in the Stock Market
December 05, 2011



The Week Ahead -- Will Money Managers Push Up Stocks? -- Markets Will Be Watching Europe For Investment Clues – Will The Dollar Confirm A New Bull Market? -- Investors Should Pay Close Attention to U.S. Dollar’s Daily Moves -- Are the Shorts Finally Losing Conviction? -- A Decrease in VIX Call Buying Suggests the Bears Are Loosening Their Grip on Equities.



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week ahead

Wall St Week Ahead sees the euro zone once again serving as the source of angst, as investors look to a summit of the region's political leaders for decisive solutions for the ballooning debt crisis.

Markets enter the week ahead slightly more optimistic that European leaders will finally show the resolve to address their sovereign debt crisis.

After an apparently restful holiday hiatus, the bulls were back in rare form last week. Stocks posted their best week in more than two years last week, driven by central bank efforts to provide cheaper dollar loans to struggling European banks.

Traders gave thanks for a particularly festive Black Friday, a bit of measurable progress on the euro-zone debt crisis, and generally well-received U.S. jobs data, and the major market indexes eventually ended the week between 7% and 8% higher.

Despite a less-than-convincing finish on Friday, it's starting to look like Wall Street may get its Santa Claus rally, after all, and maybe this will be more apparent in the week ahead.

If the market keeps rising, it could push nervous portfolio managers back into stocks...but you don’t need to wait to make sensible buys into these assets.

The new head of the European Central Bank said on Thursday the ECB stands ready to act more aggressively to fight Europe's debt crisis if political leaders agree to much tighter budget controls in the week ahead, at the December 9 summit.

But Wall Street investors can be forgiven for feeling like they've been in this position before. Markets seesawed throughout the fall, guided by prevailing sentiment out of Europe.

The week ahead will be all focused on the upcoming Friday summit. However, this is the fifteenth summit we've had now during the euro zone crisis and every one the market gets excited about and then boom - it gets disappointed!

The Past Week

The S&P 500 ended the week amid a virtual hornet's nest of potential resistance levels -- which means the stage could be set for a drastic move in either direction in the week ahead, especially as euro-zone leaders prepare for a much-anticipated summit. I definitely prefer the bull-rally scenario for the week ahead!



Reasons to Support a Rally




It was another incredible week for the stock market, as the grinding decline during Thanksgiving week discouraged many investors (but apparently not shoppers). From November 21 through November 25, the S&P 500 lost almost 57 points…only to gain 85 points last week.

Wednesday’s gain, the largest in the Dow since March 2009, caused a surge into all risk assets. The coordinated action of the central banks that caused this bump may influence the market for the rest of December.

Though volume was heavy Wednesday, many skeptics attributed the gains to short covering. This may be the case, but how the market acts after the next pullback will tell us more. Volume fell to 855 million shares traded on the NYSE and 463 million on the Nasdaq. Decliners led advancers on both exchanges by about 1.5-to-1.

Santa Rally -- Will it continue in the Week Ahead?

The stock market gained more than 7 percent in the past week as the Fed, European Central Bank and four other central banks joined to extend swap lines and make dollar borrowing cheaper, alleviating some stress on European institutions. The S&P 500 (SPX) rose 7.4 percent to 1244, its best weekly performance since March, 2009 The Dow Jones Industrial Average (DJIA) gained 787 points, or 7 percent this week. That put the blue-chip index back in positive territory for the year — it's now up 3.8 percent for 2011. The Nasdaq (COMP) gained 7.6 percent this week and the Russell 2000 jumped 10.3 percent.

Wednesday’s sharply higher open saw the risk was too high on new long positions, as wide stops needed to be used. However, selected buying near support in stocks or sectors that are outperforming the S&P 500 was still favored.

Many of the perennial bears were looking for stocks to plunge on the opening on Friday; in reaction to what they thought would be a worse-than-expected monthly jobs report – and stocks did give up there nice early gains by the close on Friday. Hopefully further pullbacks in the market are unlikely in the week ahead if certain issues are rectified.

The best performers last week were companies with more international sales, according to Bespoke Investment Group, an investment adviser in Harrison, New York.

120511-VIX chart



While volatility remains high as markets remain susceptible to any negative headlines coming out of the euro zone, investors appear satisfied for the time being that the region's leaders will remain on track in tackling the crisis in the week ahead.



The VIX and the Market’s Future Outlook




As stocks roared back from the previous weeks near five-percent losses, commodities also gained. Oil was helped by concerns about Iran, which was slapped with new economic sanctions by Western countries because of its nuclear program. Oil crossed back above $100 in the past week, gaining 4.3 percent to $100.96. RBOB gasoline was up 6.6 percent on the NYMEX to $2.6162 per gallon, lifted in part by news of another East Coast refinery shut down.

The Week Ahead

There is a fairly light economic calendar this week, with factory orders and the ISM Non-Manufacturing Index on Monday, followed by jobless claims on Thursday. The latest numbers on international trade are released Friday, along with consumer sentiment.

However, the biggest source of headlines for markets in the week ahead will be a series of meetings and events in Europe as officials work toward the summit.

The S&P 500 is still over 3% below the October highs, but the sharp improvement in the market internals suggests that stocks will surpass the October highs before the end of the year.

The news-driven market has left many individual investors—as well as some professionals—quite frustrated. Under-invested portfolio managers could fuel the next move to the upside in the week ahead, as many are uncharacteristically light on stocks. The pressure may be ongoing into the end of the year.

The next big hurdle for the Euro crisis is the December 9 meeting of Eurozone leaders, but comments last Friday by various leaders suggest that the crisis is not over.

A Technical Viewpoint –Portfolio Protection Maybe a Good Option in the Week Ahead

“As I have been saying for weeks, the sentiment backdrop favors the bulls, with many fund managers underweight equities and short interest at levels last seen in early 2009. But in the absence of a positive catalyst -- and with the major equity indexes in the red for 2011, and long-term levels of support a healthy distance below current levels -- the contrarian implications of this pessimism are less meaningful. Therefore, be open to both long and short trades amid this uncertainty and questionable technical backdrop.”
- The Week Ahead in the Stock Market, November 28, 2011

It has certainly been a difficult environment for bulls and bears alike, with longer-term resistance levels capping rally attempts, and the sentiment backdrop leaving the bears vulnerable to sharp, snap-back rallies and a breakout above resistance. In fact, most of the losses from the second half of November were wiped out in essentially two days of trading last week, and most of the action contained in those two days occurred at the opening bell. The continued stream of alternately negative and hopeful headlines related to Europe's sovereign debt issues has created drastic overnight swings, leaving the S&P 500 Index (SPX - 1,244.28) trading just below its breakeven for the year, and 24 points above the middle of its calendar-year highs and lows at 1,220 -- with the low and high being defined at 1,080 and 1,360, respectively.

The positive catalyst this past week was a surprise coordinated action by central banks to help relieve the situation in Europe, which was growing darker by the day. The central bank actions sparked a sharp rally -- and from the various analytical takes we have observed, this caught quite a few market participants flat-footed, and many doubt that the market will be able to sustain any meaningful advances following the move to bolster dollar liquidity. A contrarian would see this skepticism as intriguing, as it's a sign of sideline money and potential short-covering activity. Against this backdrop, the central banks' actions could indeed drive a rally of substance.

One indicator that needs constant attention is the action in the 20-day,

buy-to-open call/put volume ratio for CBOE Market Volatility Index (VIX - 27.52) futures options. After a long period of pronounced VIX put buying, this activity has decreased substantially, causing the ratio to turn higher from extremely low levels. When this ratio turned higher from extreme lows last year, a major market rally occurred. One difference between now and late 2010 is that the present direction of this ratio is being driven by a sharp decline in VIX put activity, whereas in late 2010, the decline in VIX put buying was accompanied by a sharp influx in VIX call buying.

The problem here is that fund managers were increasingly

shorting stocks from June through October 2011, as the VIX call/put ratio decreased. The idea is that if equities shot higher, the VIX would suddenly plunge, and losses from short stock positions would be offset by profits from the VIX put options that were purchased as a hedge. The increase in shorting activity could have capped market rallies during the June-October period, but the present decrease in short-selling could signal weakening resistance as less supply, via shorting activity, enters the market. That said, bulls would like to see an increase in VIX call buying as a sign that fund managers are accumulating long positions, which would enhance the probability of a breakout above resistance.

120511-VIX  20day buy to open since 2010



The SPX comes into the week just below major resistance in the 1,250-1,260 area, which is the site of it’s:

1. 160-day moving average

2. 320-day moving average

3. Year-to-date breakeven (1,257.64)

4. Former support -- first-half 2011 lows

Daily Chart of SPX since December 2009
With 160-Day and 320-Day Moving Averages

120511-SPX since Dec, 2009



Action to Take

With the VIX back below 30 and touching a low of 25.29 on Friday -- which is just above the 2011 half-high and the October low -- now is another good time to buy portfolio protection via short-term VIX calls or index puts, if you are long and playing for a potential unwind in pessimism that pushes stocks above resistance. The protective options would guard against another technical failure, as we had on Friday with the SPX reversing from its highs, and/or a negative outcome ahead of the European Union (EU) summit this Friday.


European Meeting

Markets enter the week ahead slightly more optimistic now that European leaders will finally show the resolve to address their sovereign debt crisis.

That doesn't mean a major solution will be announced, but analysts are more hopeful that the European Union's leaders two-day summit will end Friday with the promise of a more powerful plan to stop the spread of contagion and the threat to the global economy.

It seems that the only thing that's really significantly impacting the equity and bond market in the U.S. is what's going on over in Europe, and whether it takes a tilt to the right or left depends on whether the right set of people come out of a door and start talking.

In the past week, European Central Bank President, Mario Draghi, signaled the ECB could do more to fight the sovereign debt crisis if European leaders move toward financial integration. By the end of the week, it appeared a solution involving the IMF playing some type of administrative role was emerging. The IMF could also attract new funding to help Europe, giving emerging economies a bigger role in the process.

There are a couple of things that look like they're hopefully coming into place:-

1. There seems to be some realization by the ECB that they need to be an active participant in this even if it includes using the ECB balance sheet at some point, and

2. There also seems to be a realization that the IMF has a role to play.

Hopefully, they won't spend next Friday telling us what they can't do. The biggest change last week was they started telling us what they could do.

Behind the scenes, there's been a vote of confidence from the central banks. By doing these swap lines, it shows that they were willing to stand by the ECB’s side. That seems to mean that something else has to be coming --They don't think the euro is going away -- It's going to turn the tide of negativity -- An expectation that the EU leaders will provide a framework of a plan. Early last week, there was further talk that the euro would break up. The costs of this would be astounding, and the imbalances between the weak and strong currencies would foster a new crisis. However, it is more likely that the euro may decline on the news, if European leaders make progress, but that stocks would probably go higher in the week ahead, breaking the tight correlation between equities and the euro!

Santa Rally in the Week Ahead?

And, the pros say, it may not be over yet -- T’is the season to keep positive momentum in motion!

If Europe continues to make progress, stocks could see a "Santa Rally" as it gets closer to the end of the year and get some support into the start of the year when money goes into 401K plans and is allocated into the stock market.

Payroll Tax Cuts

Another hurdle for markets is the expiration of the payroll tax cuts, which economists say would hurt growth next year if left to expire. If Congress gets their act together and passes it, there will be another positive for stocks from the Fed meeting, if the Fed is particularly dovish.

Earnings

Earnings growth this season was better than expected and the risk of being out of the market is bigger as being in.

With nearly all of the S&P 500 having reported quarterly earnings, about 73% of those reporting have posted earnings above Wall Street consensus estimates, according to John Butters, senior earnings analyst at FactSet Research.

Eighty-one companies in the S&P 500 have issued negative earnings guidance for the current and 29 have issued positive guidance, according to Butters.

In the coming week, Autozone Inc. (AZO) and SAIC Inc. (SAI) report quarterly earnings on Tuesday. On Thursday, Brown-Forman Corp. (BF.B) and Pall Corp. (PLL) release their quarterly results.

Conclusion

The positive outlook since the start of the fall was severely tested during Thanksgiving week, but last week’s action does support the bullish case.

The market's itching to go up, there is a need to find stability and not have the negative fallout from Europe. If European leaders find a way to structure fiscal integration and if the ECB shows it is a willing lender of last resort, stocks would potentially benefit.

The news-driven market has left many individual investors—as well as some professionals—quite frustrated. Underinvested portfolio managers could fuel the next move to the upside, as many are uncharacteristically light on stocks. The pressure may be ongoing into the end of the year.

If stocks continue to move higher over the next week or two, the professional money managers are likely to become more nervous and buy more heavily. The neutral sentiment and positive market internals continues to favor buying stocks at support, but as always, use stops.

We could get a good risk-reward entry in gold over the next week or so, for what could be a strong first quarter of 2012.

So, the roller-coaster ride seems poised to continue -- but fortunately, there are several different ways to navigate this melodrama with trading put and call options.

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